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What is Capitalism?

By Sheri Cyprus
Updated May 16, 2024
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Capitalism is a socio-economic system that allows private owners to profit from the goods and services they provide. One of the cornerstones of this system is the right of the individual to choose what to produce, how to produce it, and what price to sell it for. It is popular in nations that value the freedom of the individual over the stability of the society. Most modern nations use some form of capitalism, such as state, corporate, or social market.

How It Works

Also known as the free market system, capitalism requires unregulated supply and demand and little or no government interference in matters of trade. Each individual is free to produce what he or she wants and to sell it at whatever price the market will support. These decisions are typically made by the laws of supply and demand: if there is no demand for a particular product, the producer won't be able to make a profit, but if the demand is high, he or she can sell a lot of goods.

In an ideal world, everyone benefits because producers only create what people want and consumers will only pay what they think the product is worth. The more demand there is for a product, the more goods are produced, and — ideally — the more the price goes down. In this system, competition between businesses is good for consumers because it too drives prices down and, theoretically, improves the quality of the products being sold.

The unregulated market, also known as laissez-faire capitalism, named for a French term that means "let it be," occurs when the government has no control over trade and economic concerns and allows the market total freedom. No modern nation operates this way because, in practice, the system seldom works in an ideal fashion. Rather than increasing supply and driving down the price of an in-demand product, for example, a company may keep production levels low in order to continue charging higher prices. Nearly all modern "capitalist" societies are actually mixed economies, with government-controlled competition and labor policies in place to help protect consumers, businesses, and workers.

Labor and Capital

A capitalist system operates on wage labor, with people being paid in money rather than goods or services (though some companies also supplement a laborer's income with goods and services, such as stock options). Labor works according to the laws of supply and demand as well; the more available workers who can do a particular job, the less an employer will have to pay them for their work. Workers also have the freedom to sell their services to different employers so that, if one company does not treat them well, they theoretically have the ability to quit and find a job somewhere else.

Since laborers must be paid for their work, a business requires some sort of start-up money, called capital, in order to run. This can come from a government loan, a private investment, or capital from another business owned by the same individual or corporation. Without capital, which is anything of value that has the capacity to create more wealth, businesses cannot survive in a capitalistic society.

One reason that pure capitalist systems tend to not work in an ideal way is because of the relationship between labor, or the working class, and the people who own the means of production, also called the owner class. The owner class tends to become more and more wealthy, while the working class is dependent on the owners for their survival. This can lead to distrust and unrest, especially in situations where workers feel like they are not being paid enough or are being treated unfairly in other ways. While workers can change jobs in theory, this is only possible if there are other jobs available and if those companies do, in fact, treat their workers better. Many countries have labor laws that regulate minimum wage, child labor, health and safety standards, and other areas of concern to help keep the balance of power between labor and owners a bit more even.

The Economy and the Society

Capitalism is considered a socio-economic system, not just a way of earning money and making a living. This is because it is a way of thinking about social organization; in this social-economic system, individualism is paramount and individuals must be granted the right to economic freedom. People have the right to earn money in whatever job they choose, and to spend that money however they want. In addition, those individuals must keep buying products to keep the market moving. This leads to a focus on consumerism, with people primarily defining themselves within society based on what they own rather than what they do.

Socialism is considered to be the opposite of this system because it is based on what benefits society as a whole rather than what benefits the individual. In a socialist state, the government owns most or all of the means of production and goods are produced based on what people need rather than to produce a profit. Ideally, this means that wealth is distributed evenly and there is no unemployment. As with capitalism, however, the system rarely works in an ideal fashion, and there are many different forms of socialism practiced in reality.

Types of Modern Capitalism

Nearly all modern capitalist nations actually have mixed economies, and use a blend of capitalist ideas and other systems. While some aspects of the economy may be left alone, others, such as wages or safety procedures, may be carefully monitored by the government. There are at least four main types of capitalism, although different countries use variations of each:

  • Market systems operate with limited interference from the government, allowing supply and demand to create a balanced market.
  • Corporate systems rely heavily on capital moving through large, powerful, for-profit corporations.
  • Social market systems typically include more government involvement in social welfare systems and public services.
  • State-led systems are different from the others in that the government owns the means of production, but runs them in order to make a profit.

Early History

17th century English Puritans, who were known for their strong work ethic, are often cited as the first modern capitalists because of their focus on the importance of productive labor. The origins of capitalism actually go all the way back to 16th century Europe, however, when the decline of feudalism, in which people were granted protection and possession of land in exchange for services to the lord who held the land, led to the rise of mercantilism. Mercantilism is focused on the production of goods and trade between countries, with state governments often wielding significant control.

The worldwide trade that flourished in the Age of Discovery, when nation-states were being formed and much of the world was being explored and colonized, was capitalistic in the sense that it allowed individuals and nations to generate profit. Governments and companies often worked together to increase the wealth of those companies and the state, maximizing the amount of goods that were exported and putting up barriers to keep the amount of imported goods as low as possible. During this time, powerful nations often profited mostly because they exploited the resources of less-powerful regions.

The Age of Discovery set the stage for the 17th century Age of Enlightenment, an era marked by a growing sense of individualism and a desire for greater choice. During this era, people began to take hold of their own destinies, pursuing careers and selling goods and services that they felt would allow them to profit. Though the people who lived in these centuries were becoming more capitalistic in nature, it wasn't until the Industrial Revolution this new system took off.

The Birth of Modern Capitalism

The birth of the factory in the mid-18th century is often cited as true beginning of capitalism. By creating goods that were in demand and streamlining labor, factory owners were able to maximize their profits. At this time, economists, including Adam Smith, began discussing the merits of letting the "invisible hand" take control of a country's economy. In the 19th century, the United States approached a state of true laissez-faire, but the Great Depression put an end to the unregulated business that this system demands and introduced more government control over the market.

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Discussion Comments
By anon353797 — On Nov 02, 2013

Capitalism breakdown: There is a new virus in your state. A team of local scientist develop a cure. To manufacture the cure in pill form cost the scientists $25 each dose. They sell each dose for $100. They make a profit (or capital gain) of $75.

This is capitalism because the government does not own or regulate the price the scientists can demand for each dose.

Capitalism is based on a demand for a service or product, with someone supplying that demand for a capital gain.

By socrates2 — On Apr 22, 2012

By the way, since you want shortcuts, how's this? Capitalism is the ongoing attempt to separate the individual from property and tools, using government coercion and force to accomplish this end.

Why? An individual with neither tools nor property (his means of sustenance and support) is forced to work for those with either or both--or starve. The insidiousness of this man-made process is that it sanctions predatory behavior for the historically strong and united while providing the illusion that each individual is to blame for his plight.

Those who expose this common delusion become targets of demonization and name-calling eventually getting eliminated by force. Do "Reds," "commies," "Marxist," etc., ring any bells?

Please read Michael Perelman's "The Invention of Capitalism."

By anon263001 — On Apr 22, 2012

Sadly, Capitalism and its many phases (including its history, its impact on governments and cultures, etc.) cannot be explained in a handful of paragraphs. I strongly suggest Carrol Quigley's timeless classic, freely "Tragedy and Hope." It should prove illuminating. wisegeek is cool, if you're looking for shortcuts. Otherwise, I suggest the real thing.

By anon248677 — On Feb 18, 2012

I really like this site because it explains things well enough for me to do a research report on it, which I am!

By springheelj — On Nov 03, 2011

One of the best ways I have found of understanding how capitalism works is this example: A capitalist has some money he wants to invest, so he buys some bricks for $10k. He is not intending to sell them on straight away for profit, as the price of bricks is fairly steady. What he does now is he buys another commodity, labor, for let's say $20k. He now holds commodities that he has paid $30k for. Here is the interesting bit: he combines them, putting the labor to work on the bricks, and now he has a house. We'll value the house at $40k for a round $10k profit margin.

Now, if he went crazy and deconstructed the house brick by brick, he would be left with $10k worth of bricks again. He has effectively undone the $20k worth of labor that he purchased, but this has subtracted $30k from the value of his assets. It is mostly the difference between these two separate values of labor ($20k and $30k here) which is the source of profit.

By anon217765 — On Sep 26, 2011

Keynsian economics made the great depression worse, not better. It is false that "Keynesian economic methodology continues to further the growth of capitalism today."

Keynesianism is at odds with capitalism. It posits that property exists for the public good, and can be redistributed at will. This statement is like saying that the Greek empire was strengthened by the conquering Roman empire.

By anon132499 — On Dec 07, 2010

It is good to have brilliant people like you who explain concepts and terms with such a degree of clarity.

Thank you once again. --Juliet(Ugda)

By anon132497 — On Dec 07, 2010

Thank you for the clarity on the rather hard terms. I am grateful to you for the useful text.

By anon126677 — On Nov 13, 2010

@anon92498: Are you serious? Wow, you are very uninformed. It was due to too much government regulation, and lowering interest rates and printing money that has caused the credit crunch. That was definitely not the free market.

By anon92498 — On Jun 28, 2010

as you can see capitalism has put us into a credit crunch so it has had its time.

By anon77337 — On Apr 14, 2010

Eyvnonne, capitalism is economically based, not politically. Democracy is a political view.

Democracy is where the people directly control the government and elect officials, whereas capitalism is an economic system in which individuals own businesses privately and make profit for themselves.

This differs from socialism and communism in which everything is communally owned and the profits are shared. Hope this helps. - Marshall

By anon67950 — On Feb 27, 2010

Can anyone give me a small, simple, easy definition of capitalism, please?

By anon37879 — On Jul 22, 2009

Which countries around the globe follow the ideology of communism and socialism??

By Eyvonne — On Oct 28, 2008

So what I thought was capitalism is democracy?

By Eyvonne — On Oct 28, 2008

I always thought capitalism was based on the idea of individualism and that people have the right to economic freedom....but I was told that is democracy. I was told democracy has to do with the system of government. Capitalism has to do with the system of economy. And that you can have have democratic countries that are socialists and you can have communist countries that are capitalist...they are not dependent upon each other.

In this country the president has no control over the direction of the the policy of the business community..so if you understand that, then you can appreciate that if we do move in that direction, it is because the stewards of business want us to move in that direction. That direction being, from capitalism to socialism. I'm so confused I don't know what is right?????

By agville — On Oct 21, 2008

i'm still confused, is capitalism just the government letting go of all economic related holdings, such as regulating trade, prices, and supply of goods? in other words, it is all controlled by the people? and it is your choice to make money or not, meaning if you are unemployed, living in poverty, etc., it's your own fault?

By anon17508 — On Aug 31, 2008

Thank you so much!!! You really helped me understand what capitalism actually is. Now I can include it in my college paper! Don't worry, I'll give you credit. But thanks again!=D

By AuthorSheriC — On Aug 03, 2008

You're welcome. I'm glad you found this article so helpful!

By anon16115 — On Jul 29, 2008

This was great! I was really confused about the differences, but now it's completely clear!! Thanks for being so straightforward.

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